We
granted review to consider an issue of first impression
regarding whether an insured forfeits insurance coverage by
settling a tort claim without the consent of its insurer,
when the insurer defends the insured

Page 447

subject to a reservation of rights, asserting that the claims
may not be covered by the policy. After review, we reverse
the decision of the Superior Court and reinstate the judgment
of the trial court.

The
case history spans two decades, beginning with the 1994
filing of a federal class action lawsuit against
Appellant-Insureds Babcock & Wilcox Company (B& W) and
Atlantic Richfield Company (ARCO) (collectively, Insureds)
brought by plaintiffs claiming to have suffered bodily injury
and property damage caused by emissions from nuclear
facilities owned by Insureds.[1] Over time, the class
action grew to include over 500 named plaintiffs, who lived
near the nuclear facilities. Insureds denied that the
facilities released any emissions or that the harm suffered
by plaintiffs resulted from the facilities. Nevertheless, a
1998 jury trial of eight test cases resulted in an initial
verdict totaling over $36 million or approximately $4.5
million per plaintiff. The federal court, however, granted a
new trial due to evidentiary issues. The retrial was never
held given the subsequent settlement discussed below.

While
the underlying tort action was pending in federal court,
disputes arose between Insureds and their insurers, Appellees
American Nuclear Insurers and Mutual Atomic Energy Liability
Underwriters (collectively ANI or Insurer). At the outset of
the litigation, Insurer acknowledged that it would defend
Insureds but contested whether the policy covered aspects of
the claims, and thus defended subject to a reservation of
rights. Specifically, in 1994, Insurer, inter alia,
asserted that the policy did not cover damages that were not
caused by nuclear energy hazard, damages in excess of the
policy limits, and claims for injunctive relief and punitive
damages. Letter of June 20, 1994, R.R. at 148a-151a. The 1994
reservation of rights was supplemented as to B& W in October
1999, by a letter indicating, inter alia, that
Insurer reserved its right to disclaim coverage for
Insureds' liability based upon Insureds' pressuring
of Insurer to settle, which Insurer viewed, in connection
with other actions, as a breach of Insureds' duty to
cooperate.[2] Letter of October 5, 1999, R.R. at
3206-08.

While
the details are not relevant to the current dispute, Insurer
filed a declaratory judgment action in state court days after
the 1999 reservation of rights letter, raising challenges
relating to the coverage limit, whether B& W and ARCO were
entitled to separate representation, and bad faith and breach
of contract allegations, including the breach of the duty to
cooperate, against the Insureds. The Insureds counter
claimed, raising bad faith allegations against Insurer. While
staying various claims for future determination, including
the breach of the duty to cooperate claim, the court decided
issues regarding the trigger of coverage and held that B& W
and ARCO were entitled to separate counsel. The Superior
Court affirmed on appeal, and this Court denied
allocatur.[3]

Page 448

During
the course of the litigation, Insurer refused consent to any
settlement offers presented to it due to its conclusion that
the case had a strong likelihood of a defense verdict given
the lack of medical and scientific support for
plaintiffs' claims and decisions by the federal trial
court regarding procedural and evidentiary issues in the
pending retrial, which Insurer viewed as highly favorable to
Insureds' ultimate outcome. Nevertheless, after
presenting the settlement offers to Insurer and being denied
consent, Insureds ARCO and B& W, respectively in 2008 and
2009, settled with the class action plaintiffs for a total of
$80 million, which was substantially less than the $320
million of potential coverage.[4]

Insureds
then sought reimbursement of the settlement amount from
Insurer in the Allegheny County Court of Common Pleas.
Insurer countered that reimbursement was not permissible
because the insurance contract contained a standard consent
to settlement clause, also referred to as a cooperation
clause, requiring Insureds to cooperate with Insurer and to
obtain Insurer's consent to settle:

Assistance and cooperation of the Insured. The insured shall
cooperate with the companies, and upon the companies'
request, attend hearings and trials and assist in making
settlements, securing and giving evidence, obtaining the
attendance of witnesses and in the conduct of any legal
proceedings in connection with the subject matter of this
insurance. The insured shall not, except at his own cost,
make any payments, assume any obligations or incur any
expense.

Insurance
Agreement, Condition 6, Reproduced Record (R.R.) at 59a.
Under the insurance policy the decision to settle rested
exclusively with Insurer which " may make such
investigation, negotiations and settlement of any claim or
suit as they deem expedient." Id. at I(A)(1),
R.R. at 57a. Moreover, the policy expressly did not cover
" liability assumed by the insured under contract . . .
." Id. at Exclusion (c), R.R. at 58a.

Relevant
to the question at bar, the trial court recognized that the
case presented the issue of " under what circumstances
will a court require an insurance company, whose policy is
found to provide coverage, to reimburse an insured that
settled the underlying litigation over the objections of the
insurance company" in a case involving a standard
consent to settlement clause when the insurer has defended
its insured subject to a reservation of rights. Tr. Ct. Op.,
July 5, 2011 at 2. As discussed in more detail below,
Insureds asserted that Insurer should reimburse Insureds for
the settlement so long as coverage applies and the settlement
is fair and reasonable and entered in good faith, a test
derived in part from the seminal case of United Services
Auto. Ass'n v. Morris,154 Ariz. 113, 741 P.2d 246
(Ariz. 1987) (hereinafter " Morris fair and reasonable
standard" ). Insurer, in contrast, argued that the
obligation to pay the settlement could only be imposed on
Insurer if it acted in bad faith in refusing to settle,
seeking application of this Court's test in Cowden v.
Aetna Cas. and Sur. Co.,389 Pa. 459, 134 A.2d 223 (Pa.
1957), where we held that an insurer must pay a judgment in
excess of policy limits for its bad faith failure to settle
below policy limits

While
initially opining in December 2009 that the Cowden bad faith
standard should apply, the trial court reconsidered its
decision in July 2011 and applied the Morris fair and
reasonable standard. Judge R. Stanton Wettick reasoned that
while the interests of insurers and insureds generally align
when the insurer has accepted responsibility for defense and
indemnity, the parties' interests increasingly diverge
the more the insurer believes the policy does not cover the
claims, as when the insurer defends under a reservation of
rights. He observed that, in a reservation of rights case, an
insured would prefer to cap the potential liability as it
ultimately may be responsible for the full settlement in the
event that insurer is successful in its challenge to
coverage, whereas the insurer does not want to settle as it
would relinquish its challenge to coverage. Tr. Ct. Op., July
5, 2011 at 5. Relying upon Morris and decisions from other
jurisdictions, the trial court opined that a reservation of
rights case is more akin to a case where an insurer has
refused coverage and defense. Id. at 5-6.
Accordingly, the court adopted the test forwarded by Insureds
under which an insurer, defending subject to a reservation of
rights, is required to reimburse an insured for a settlement
reached in violation of the consent to settle clause where
coverage is found to exist and the settlement is " fair
and reasonable" and made in " good faith and
without collusion." Id. at 6-11(citing in
support Insurance Co. of North America v. Spangler,881 F.Supp. 539 (D. Wyo. 1995); Morris, 154 Ariz. 113, 741
P.2d 246; Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d
637 (Iowa 2000); Patrons Oxford Ins. Co. v. Harris,2006 ME 72, 905 A.2d 819 (Me. 2006); and Martin v.
Johnson,141 Wn.App. 611, 170 P.3d 1198 (Wash. Ct.App.
2007)); Tr. Ct. Order, July 5, 2011(providing that Insurer
shall reimburse Insureds if the Insureds establish that the
settlement was " fair and reasonable" unless
Insurer establishes that " there is no coverage"
under the policies for reasons unrelated to the
settlement).[6]

Following
the court's decision, a two-week trial was held where a
jury determined that Insureds' settlement with plaintiffs
was fair and reasonable. The trial court, then, molded the
verdict to include prejudgment and post-verdict interest.
Insurer appealed to the Superior Court seeking application of
the Cowden bad faith standard. The Superior Court recognized
that this case presents an issue of first impression in
Pennsylvania, which has nonetheless been addressed by various
state and federal courts. The court further observed that the
question is subject to well-settled basic principles of
Pennsylvania insurance law. The court emphasized that
insurance policies are contracts at heart, controlled by the
language of the policy, but which include unique policy
concerns requiring that any ambiguity be interpreted in favor
of the insured.

The
court reiterated that Pennsylvania distinguishes between the
duty to provide coverage and the broader duty to defend,
which applies when the claim may potentially come within the
coverage of the policy. The panel acknowledged that the
insurer's broad duty to defend is balanced

Page 450

by an insurer's option to defend subject to a reservation
of rights. It emphasizes that the utilization of the
reservation of rights is not a breach of contract but instead
is encouraged, as it provides insureds with a defense in all
cases of potential coverage while coverage is being
determined.

While
acknowledging the permissible use of reservation of rights,
the Superior Court detailed the potential for a conflict of
interest between an insurer defending under a reservation of
rights and an insured, who would be subject to full liability
if its claim is eventually determined not to be covered. The
panel recounted concerns raised in other courts that insurers
will be less zealous in defense and less willing to settle if
the insurers believe that they will ultimately not be liable
for coverage. Acknowledging insureds' interest in
settling reservation of rights cases, the Superior Court
noted that allowing insureds to settle seemingly violates the
clear language of the policy requiring the insurer's
consent to settlement and presents the potential for
collusion between an insured and a plaintiff.

The
Superior Court categorized judicial responses to these
concerns as falling into two broad categories. It contended
that a number of courts, like the trial court in this case,
follow Morris, 154 Ariz. 113, 741 P.2d 246, holding that an
insurer may be liable to reimburse a settlement that is fair,
reasonable, and non-collusive, if coverage is determined to
apply. The second category, which is championed by ANI in the
case at bar, includes Vincent Soybean & Grain Co., Inc.,
v. Lloyd's Underwriters of London,246 F.3d 1129
(8th Cir. 2001), and resembles Pennsylvania's Cowden bad
faith standard, although Pennsylvania cases have not applied
the standard when the insured has settled absent an
insurer's consent. Vincent Soybean and other like cases
emphasize that an insured breaches the insurance policy when
it settles without the insurer's consent. These cases,
therefore, have required the insured to demonstrate that the
insurer acted in bad faith in refusing to settle before
requiring insurer to pay the settlement. The Superior Court
opined " that the Morris and Vincent Soybean approaches
tilt the playing field too much in favor of, respectively,
the insured or the insurer. There is, however, a third
approach, an approach that we believe best balances the
interests of the insurer and the insured." Babcock &
Wilcox Co. v. American Nuclear Insurers, 2013 PA Super
174, 76 A.3d 1, 17 (Pa. Super. 2013).

[W]e hold that, when an insurer tenders a defense subject to
a reservation, the insured may choose either of two options.
It may accept the defense, in which event it remains
unqualifiedly bound to the terms of the consent to settlement
provision of the underlying policy. Should the insured choose
this option, the insurer retains full control of the
litigation, consistently with the policy's terms. In that
event, the insured's sole protection against any injuries
arising from the insurer's conduct of the defense lies in
the bad faith standard articulated in Cowden.

Alternatively, the insured may decline the insurer's
tender of a qualified defense and furnish its own defense,
either pro se or through independent counsel
retained at the insured's expense. In this event, the
insured retains full control of its defense, including the
option of settling the underlying claim under

Page 451

terms it believes best. Should the insured select this path,
and should coverage be found, the insured may recover from
the insurer the insured's defense costs and the costs of
settlement, to the extent that these costs are deemed fair,
reasonable, and non-collusive.

Id. at 22. Applying this test to the case at bar,
the court remanded for a new trial on " 1) whether
[Insureds] in fact rejected [Insurer's] defense; and, if
not, 2) whether [Insurer] acted in bad faith in declining to
settle" or participate in settlement negotiations.
Id.[7]

Notably,
the Taylor/Insured's Choice Test approach was not
forwarded by either Insurer or Insured, and indeed, both
parties vehemently object to the Superior Court's
adoption of the test because an insured under Pennsylvania
law does not have the option of " rejecting" an
insurer's defense as it would constitute a breach of the
insurance policy, thereby releasing the insurer from the
obligation to provide coverage. See American and Foreign
Ins. Co. v. Jerry's Sport Center, Inc.,606 Pa. 584,
2 A.3d 526, 545 (Pa. 2009) (" [W]here the claim was
potentially covered, Insured would have been at risk of
breaching the insurance contract if it had rejected [the
insurer's] defense and it was later determined that the
claim was covered." ). Moreover, the parties observe
that most insureds would be unable to utilize the
Taylor/Insured's Choice Test approach as they would not
have the funds to allow them to employ an independent defense
after rejecting the insurer's defense for which they had
paid premiums to obtain. Accordingly, for these reasons, we
likewise reject the Superior Court's holding as
unworkable under Pennsylvania law and turn to the arguments
presented by the parties to determine which approach to
adopt.

As
noted, we granted review to consider as an issue of first
impression whether an insured forfeits the right to insurance
coverage when it settles a lawsuit without the insurer's
consent, where the insurer has defended the suit subject to a
reservation of rights.[8] Insureds advocate adopting the Morris
fair and reasonable standard. They contend that when an
insurer defends subject to a reservation of rights, an
insured must be able to protect itself from the potential of
an adverse and uninsured decision in the underlying tort
case, if the insurer is ultimately deemed correct in
concluding that the policy does not cover the claim. Further,
Insureds claim that the insurer in a reservation of rights
scenario is " in the attractive position of being able
to avoid exposure either because the insured prevails at
trial or because the insurer's coverage defense is
successfully asserted[.]" Insureds' Brief at 33.
Insureds contend that the Morris fair and reasonable standard
provides protection for the insured by allowing the insured
to accept settlement, while still preserving the
insurer's rights to contest coverage, challenge the
fairness and reasonableness of the settlement including
whether it resulted from fraud or collusion, and maintain
control over other aspects of the defense

Page 452

including the choice of counsel and the defense strategy
prior to settlement.

Delving
further into the underpinnings of the Morris fair and
reasonable standard, Insureds observe that the court in
Morris held that an insurer's reservation of rights
" narrows the reach of the cooperation clause and
permits the insured to take reasonable measures to protect
himself against the danger of personal liability."
Insureds' Brief at 30 (quoting Morris, 741 P.2d at 252.)
Insureds observe that other courts have adopted similar
standards, including Miller v. Shugart, 316 N.W.2d
729 (Minn. 1982), and Patrons Oxford Ins. Co., 2006
ME 72, 905 A.2d 819. Insureds, however, recognize that
contrary authority exists criticizing the Morris fair and
reasonable standard, but they argue that those cases,
including Vincent Soybean, discussed by the Superior Court,
involved factually distinct circumstances, where the
insured's lack of cooperation extended beyond merely
settling the claim without the insurer's consent and
included refusing to inform the insurer about the settlement
offer or include insurers in any of the defense.

Insureds
insist that the Morris fair and reasonable standard is
consistent with Pennsylvania insurance law. They emphasize
that the Morris fair and reasonable standard acknowledges the
propriety of an insurer's decision to defend under a
reservation of rights, emphasizing that such act in no way
breaches the insurer's duties under the insurance policy.
The standard, according to Insureds, recognizes that the
insurer's decision to defend under a reservation of
rights does not permit the insured to breach the duty to
cooperate in the defense, but rather alters the relative
duties. Insureds explain their position:

To the contrary, . . . the insured must continue to satisfy
its cooperation duties, such as sharing information with its
insurer, responding to insurer requests, permitting an
insurer to participate in settlement negotiations, and, of
course, seeking insurer consent prior to entering settlement.
Under the Fair and Reasonable Standard, in one respect, and
only one respect, is the insured's " cooperation
duty" adjusted in light of the insurer's assertion
of its intention to reserve the right to disclaim coverage.
And that is, when the insurer has reserved its right to
disclaim coverage for a settlement or judgment, the insured
is no longer duty-bound to refuse to enter into a fair,
reasonable and non-collusive settlement simply because the
insurer refuses consent. For, if the insurer is reserving its
right to disclaim, thereby placing its insured in the "
precarious" position widely noted, then the contours of
the insured's duty to cooperate cannot properly be
considered to extend so far as to include a duty to forego a
fair and reasonable settlement solely because its insurer
wishes to force a trial or to permit a forfeiture of coverage
simply because the insured proceeds to enter into such a
settlement.

Insureds'
Brief at 35-36 (emphasis omitted).

In
support, Insureds observe that Pennsylvania insurance law
" prohibits a mechanistic approach to interpretation of
insurance policy conditions." Insureds' Brief at 37
(citing Brakeman v. Potomac Ins. Co.,472 Pa. 66,
371 A.2d 193, 196 (Pa. 1977) (requiring an insurer to
demonstrate prejudice before deeming the insured to have
forfeited its insurance coverage by failing to satisfy the
notice requirements of the insurance policy)). Insureds also
note this Court's instruction that the " insurer
must show that the breach is something more than a mere
technical departure from the letter of the [insurance
contract. Instead, it

Our website includes the first part of the main text of the court's opinion.
To read the entire case, you must purchase the decision for download. With purchase,
you also receive any available docket numbers, case citations or footnotes, dissents
and concurrences that accompany the decision.
Docket numbers and/or citations allow you to research a case further or to use a case in a
legal proceeding. Footnotes (if any) include details of the court's decision. If the document contains a simple affirmation or denial without discussion,
there may not be additional text.

Buy This Entire Record For
$7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.